Negative free cash flow in Europe, slowing in China and the US, scandal in Spain, and telecom consolidation

China: The biggest news this morning was the Chinese data that came in overnight, showing China growing at 7.5% in Q2. Here’s what we know. China’s data collection integrity is questionable and likely skewed to the upside. So any slowdown is real. China is now in its second annual attempt to switch to a domestic consumption-based growth model. Last year, when China attempted the rebalancing, the economy tanked, forcing reflation. Policy makers are keen to get credit under control now but not at the risk of a tanking economy. We should see 7% annualized growth as the bogey for reflation, meaning the Chinese reaction function could kick into gear in the second half of this year given current slowing trends. In the meantime, expect the Chinese slowdown to feed negatively into EM growth, Australian growth and the industrial commodities cycle. The impact on developed economies is still unclear though some media outlets are pointing to a feedback into Germany where exporters have seen China as an alternative to the periphery in maintaining Germany’s mercantalist-oriented growth model.

China Growth Slows to 7.5% as 2013 Target Under Threat: Economy – Bloomberg

China Slump Ripples Globally –

This is what I have been pointing to. The slowdown in China and EM is the one to watch now, whereas Europe’s slowdown is not as severe. At some point, however, I expect reflation from Chinese policy makers.

“As the numbers pile up showing China’s sizzling growth cooling down, industries world-wide—from German paper-cutter makers to Indonesian palm-oil exporters—are confronting an altered landscape of winners and losers.”

United States: In the US, the focus was on June retail sales where the numbers released this morning were below estimates of an increase of 0.8% at 0.4%. The numbers were buoyed by big auto sales. When you strip out volatile numbers, the reading was flat versus May, meaning that retail sales in the US have stalled. Moreover, the 0.6% May increase was revised down to a 0.5% increase. And downward revisions are usually a sign of a central tendency toward slowing. This suggests to me once again that the Fed is too optimistic and that the US is slowing. Add in fiscal tightening I expect to occur in the next few months and you have a conundrum for the Fed in terms of when they actually taper. The (U-3) headline jobs number in the US has been declining, giving the Fed cover for tapering. However, inflation and inflation expectations have fallen below the Fed’s unwritten 1% lower threshold and retail sales growth is declining on the back of wage deflation. Consumers in the US are only able to continue buying by borrowing (against increased house prices) and while job growth supports some releveraging, I am not expecting the pace of releveraging to be high. In the absence of wage growth, this recovery will stall. QE is no panacea as it is only a signal to the Fed’s reaction function – a signal that markets believe shows tightening. Expect the Fed to increasingly communicate that tapering/QE have nothing to do with interest rate policy and that zero rates will continue indefinitely irrespective of QE.

U.S. retail sales rise less than expected, building materials fall | Reuters

Europe: The piece of news I want to highlight is Fitch’s commentary on European corporate free cash flow, which they expect to be negative. In the midst of still tight credit, negative free cash flow will translate into declining capital expenditure and be a drag on growth, earnings and equity multiples. I still have a constructive view on the delta in Europe, because the pace of contraction is declining. However, yet again, we are getting a major data point that points to downside risk in Europe. That’s it for now on the macro picture there.

Fitch sees 2013 negative free cash flow for corporates | Capital City | IFRe

This is a big deal because it will hold down earnings multiples and put a cap on share appreciation. If true, I would see it as a lingering sign of how much money in terms of net financial assets austerity politics has sucked out of the private sector.

On Spain, I said months ago I would have expected the government to fall on this slush fund scandal which for me was reminiscent of a similar scandal in Germany over a decade ago that kept Merkel’s party out of power. But Rajoy has somehow kept power despite his poor polling numbers and the very negative economy, jobs outlooks and credit picture. With the latest revelations that Rajoy received payments from 2008-2010 from an illegal slush fund, I wonder how long he can hold on with the Socialists calling for his resignation. This crisis is a major black swan for Europe and could trigger the OMT application for Spain I have been predicting. I see this particular political scandal as the ost important one in Europe.

Spanish prime minister rejects calls to step down over scandal | Reuters

BBC News – Spain Barcenas scandal: Rajoy rejects resignation calls

Bárcenas asume la autoría de los papeles y da decenas de documentos contra el PP | Política | EL PAÍS

Bárcenas testifies as Spain’s political crisis deepens –

Technology: The big trend in technology continues to be consolidation. AT&T is now on the warpath, acquiring Leap Wireless in the US and reputedly on the lookout for deals in Europe. It bears noting that there are almost no synergies between the European telecoms market and the American one. T-Mobile and Vodafone both made big splashes into the US market in the 1990s and last decade and both companies are not seeing any benefit from those moves for their core business. While Verizon Wireless provides Vodafone with good dividend cash flows, Vodafone is a minority shareholder in a business that is isolated from its European operations. The fact that AT&T is trying to do in Europe what Telekom and Vodafone failed to do in North America should tell you that merger value destruction is something to be very concerned about. Also note the massive 88% premium for Leap Wireless for more on this.

AT&T to pay hefty $1.2 billion for Leap in latest telco deal | Reuters

AT&T Scours Europe for Discount Deal Targets: Real M&A – Bloomberg 

The rest of the links are below.

Bankers Are Balking at a Proposed Rule on Capital –

Microsoft Surface RT review | PC Pro

Danish funds sue banks in U.S. for blocking CDS exchange-trading | Reuters 

The dangers of Europe’s technocratic busybodies –

After Bernanke, make unconventional policy the norm –

Ratings agency Moody’s warns risk of credit rating downgrade –

This is the opposite of what S&P are doing.

By prosecuting Fabrice Tourre but not Goldman Sachs, the SEC courts failure | Heidi Moore | Comment is free |

BBC News – The receding threat from ‘peak oil’

Every time I see one of these articles, I think they are wrong because the assumption is that peak oil is about running out of oil when in fact it is about running out of CHEAP oil. The reason we have things like the shale boom and the Deepwater Horizon drilling accident is because there is limited supply of the cheap stuff. Peak oil is about prices rising enough to encourage prospecting of these more difficult sources.

Spotify Defends Against New Music Backlash, Says It Will Pay Out $1B To Artists In 2013 | TechCrunch

Denmark Invites Bank Free-for-All in Rules Fight: Nordic Credit – Bloomberg

“Denmark’s central bank is inviting financial instability by urging the nation’s lenders to ignore a European rule easing how risks for small- and medium-sized business loans are calculated, an industry group said. “

Sober Look: Portugal’s socialists walking the nation toward debt restructuring

Not sure if I agree with the conclusion that it’s the socialists that are leading Portugal to restructuring. I would say it is the unattainable front-loaded austerity that is leading them there.

Massive ice sheets melting ‘at rate of 300bn tonnes a year’, climate satellite shows – Science – News – The Independent

Obama’s secret kill list – the disposition matrix | World news | The Guardian

What If Bernanke Could Be Blunt – Washington Wire – WSJ

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